This week, the IEA said that U.S. shale would dominate the oil and gas markets over the next decade, rising to “a level 50 percent higher than any other country has ever managed.” With a “remarkable ability to unlock new resources cost-effectively,” U.S. shale will add millions of barrels of new oil supply by 2025.
But some view such heady predictions as fanciful. There are a variety of reasons why U.S. shale could struggle to add several million additional barrels per day over the next few years. But here are just a few.
First, shale suffers from steep decline rates, much steeper than conventional wells. That means drilling is like running on a treadmill—more and more wells need to be drilled just keep production flat. The extraordinary rate of drilling over the past few years means that the industry not only needs to keep going at that frenzied pace, but it needs to expand its rate of drilling to add more barrels.
Just to cite a small example of the challenge the industry faces, the Permian Basin—the most prolific in the U.S.—has a legacy decline rate that has exploded over the past few years.
According to the EIA, the basin will lose 165,000 bpd of production in December, meaning that the industry needs to add that amount in fresh supply to keep output from falling. The agency does see the industry bringing 223,000 bpd of new supply online in December, but that nets out to only an addition of 58,000 bpd after the decline rates are factored in. The Permian hasn’t yet seen its output peak, but it will be very tall task to keep production growing for years to come, especially since the decline rate grows larger and larger.
Second, drillers go after the sweetest spots first, which means that they will have to downgrade to less desirable locations in the years ahead. That makes the job of growing production all the more difficult.
Third, the rig count has already started to decline in the past few months, evidence that shale drillers were sputtering with WTI in the low $50s per barrel.
Which brings us to the fourth, and perhaps most important point: the shale industry, by and large, is not profitable. It wasn’t at $100 per barrel, and it hasn’t been at $50 per barrel. There are, surely, some exceptions, but in the aggregate, shale drillers are burning through more cash than they are generating.
Fifth, without profitability, Wall Street will sour on the industry. The only thing keeping the shale bonanza going is extremely loose credit and plenty of hungry investors that have been hoping the enormous growth rates would someday translate into profits. That has thus far not been the case.
Investors have not abandoned the industry yet, but they are pressuring companies into dialing back on drilling in favor of focusing on profits. There are signs that shale executives are finally heeding the advice of their impatient shareholders. Gordon Douthat, an analyst at Wells Fargo, told the WSJ that more and more companies are starting to say that “even if we get some upside in the commodity, we’re not going to plow that into the ground—we’re going to remain disciplined.” Related: Oil Tycoon Hamm Slams EIA’s Overoptimistic Shale Forecasts
The WSJ cited the case of Marathon Petroleum, which has laid out a capital spending plan for 2018 that assumes an oil price of $50 per barrel. If oil prices end up much higher than that, the company will probably use the extra cash to pay down debt rather than step up drilling. The more companies restrain themselves, the less production growth the shale industry will achieve.
Morgan Stanley recently came out as one of the more skeptical voices on the shale boom. The investment bank said in a recent research report that it is highly unlikely that U.S. shale adds the 1 mb/d next year that a lot of other analysts assume is in the pipeline. "Right when the world's reliance on shale is growing, its limits are starting to become apparent, and there seem to be two aspects to this: ability and willingness," Morgan Stanley analysts wrote last week.
In the latest quarterly reports, a group of 18 shale companies reported an average increase in oil production by just 1 percent compared to last year’s levels, “hardly the runaway growth that overwhelms the oil market,” Morgan Stanley analysts wrote.
By James Stafford of Oilprice.com
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